How you handle your personal finances can go a long way in determining you overall financial well-being. If you are good at handling it, you can be on path to financial independence even with a decent (not necessarily high) income. Conversely, if you don’t handle your personal finances well, you may end up never being financially independent even though you may be making tons of money. In this post, I’ll be sharing my take on basic principles of handling personal finance!
Much has been already written about the basic principles of personal finances that can help you move ahead in direction of your financial goals. And frankly, it is not a rocket science.
Here are my 2 cents on the principles of personal finance which can enable you reach closer to your financial goals.
All seemingly obvious, yet often conveniently forgotten.
1. Keep expenses less than earnings
Pretty obvious. Isn’t it? Yet many of us fail to follow it. If your expenses exceed your income, then soon you’ll lend up in a debt trap (personal loan, credit card debt and so on) and may soon need a major lifestyle re-haul to escape it. And this may come at a cost – not just financial cost.
2. Invest the difference between your income and expenses.
Assuming, you keep your expenses less than income, what do you do with the balance money? Hopefully, it is not lying idle in your savings account (barring some buffer amount which you must have for any unforeseen emergency).
This difference amount should ideally be invested in some asset class which can give you good returns for the future. You can choose a mix of some of the following – equities, equity mutual funds, debt funds, PPF, real estate, gold and so on. Most of these investments come with their own merits and demerits, which you should evaluate before investing and take a informed decision. However, you should avoid putting all eggs in same basket and any long term investment must consist of a mix of different asset classes.
3. Avoid debt
Debt is potentially a big money guzzler. And peace of mind guzzler too. While taking debt, especially the ones with higher interest rate like personal loans or credit card defaults, you are making compounding work against you. With debt end up paying much more than the cost of the stuff you are buying, and in all probability you are without the buffer to invest and take benefits of compounding over a long run.
Some forms of debt like housing loan may be OK (since you are buying an asset/ place of residence, and interest rates are not too high, plus they come with tax benefits), but for any other, you should rethink, and preferably avoid altogether.
4. Beware of the instant gratification trap and impulse buying
We all seek gratification in some form or other. Isn’t it? However, for most of us, seeking instant gratification can lead to some terrible consequences in personal finance. Be it buying the clothes or accessories you don’t need (but hey, there is a sale!) to downing few expensive tequila shots for few minutes of thrill (and hours of hangover!) to seeking gratification in gaming zones and concerts frequently – they don’t come cheap.
Of course, you should be enjoying things you like and enjoy, but constant pursuit of instant gratification comes at a cost. And you need to ask yourself the question – Are you ready to bear that cost?
One of the ways to reduce your expense of “gratification” can be the 24 hour rule (or a variation of it). If you want to buy something, don’t buy it immediately. Wait for 24 hours, think over it and then take a decision whether to buy that thing or not. You’ll be amazed at how many things you don’t need.
5. Manage risk
Think about how will you deal with sudden health issue. Or how will your family cope if the sole breadwinner is no more. Get adequately insured – a good health insurance and term insurance can be good points to start with. Be cognizant of different types of risks – risk to life, risk to health, risk to investments and its growth, risk of job loss and so on.
There are several approaches one can take to invest and grow money – and many of these ways can be correct. However, you can’t grow and invest money with a negative or near-zero cash flow. To begin with, one needs to have a certain degree of control over personal finances. And ensuring that you follow some basic principles of personal finance can be a good starring point.